Welcome to the new Becker-Posner Blog, maintained by the University of Chicago Law School.

12/31/2006

Charitable Foundations--Posner's Comment

I agree with Becker that the great strength of charitable foundations, and the principal justification for the tax exemption (though a secondary one is to offset the free-rider problem in charitable giving--if you give to my favorite charity, I benefit, and so the more you give the less I will be inclined to give), are that they bring about a decentralization of charitable giving, breaking what would otherwise be a governmental monopoly and thus reducing the play of politics in charity. In addition, however, to the extent that charitable giving substitutes for government spending, such giving (minus the tax benefits to the giver) represents a form of voluntary taxation, like state lotteries. Given the enormous skewness of incomes in today's United States, it is good to encourage voluntary taxation of the wealthy. But I would not place much weight on competition by universities and other recipients of charitable giving for foundation grants, since the recipients will compete whatever the source; universities compete for government grants just as they do for private grants.
A perpetual charitable foundation, however, is a completely irresponsible institution, answerable to nobody. It competes neither in capital markets nor in product markets (in both respects differing from universities), and, unlike a hereditary monarch whom such a foundation otherwise resembles, it is subject to no political controls either. It is not even subject to benchmark competition‚Äîthat is, evaluation by comparison with similar enterprises‚Äîexcept with regard to the percentage of its expenditures that go to administration (staff salaries and the like) rather than to donees. The puzzle for economics is why these foundations are not total scandals. The solution to the puzzle seems to me twofold: the foundations are controlled by trustees, whose prestige is invested in the success of the foundation; and foundations are constrained by law, as well as by the limited benchmark measure that I mentioned, to give away most of their income, and this limits the ability of staff to appropriate the foundation's income for its personal benefit.
A deeper puzzle relates to the leftward drift in foundation policies that Becker discusses, a drift enabled by the perpetual character of a foundation. (I agree that foundation staff work is attractive to liberals and that the children of the founders tend to be more liberal than their fathers. In both cases the main reason is probably that while the creators of the major foundations invariably are successful businessmen, and business values are conservative, foundation staff are not businesspeople and many children of wealthy businesspeople do not go into business either.) The puzzle is why conservatives establish perpetual foundations. Don't they realize what is likely to happen down the road? The answer may be that the desire to perpetuate their name is greater than their desire to support conservative causes. In any event, a rule forbidding perpetual foundations would be paternalistic. If rich people want to squander their money on feckless foundations, that should be their privilege. Moreover, to the extent that foundation spending substitutes for government spending, the comparison is of two inefficient forms of enterprise, and the foundations may be the less inefficient form.
I agree with Becker that the fact that a person like Bill Gates or Warren Buffet is a great businessman doesn't give him any comparative advantage in doing good. I also question the appropriateness of American foundations' spending money abroad. A foreign aid program is an instrument of U.S. foreign policy that can be undermined by private expenditures in the amount now being spent abroad by the Gates Foundation. And I have trouble understanding why American taxpayers should (via the tax breaks for charitable giving) help finance foundations' contributions to foreign countries. At the same time, critics of the small percentage of U.S. GDP that the United States devotes to foreign aid ought in fairness to add in the foreign giving by our foundations in calculating that percentage.
There is a further question, given that Gates and Buffet remain active in business, how much of their charitable giving is actually in support of their businesses. This is a particular conern with regard to Gates because Microsoft operates worldwide and is a controversial company. The Gates Foundation helps to polish Microsoft's image. There is nothing wrong with corporate image building, but there is no reason to favor it with tax breaks.

Comments

You can follow this conversation by subscribing to the comment feed for this post.

It's interesting to consider what the Gates Foundation declares to be the "other half" of its mission: improving American education. Perhaps it's just my overextended utilitarian neuroses, but I've always found this a little suspect. How are educational ventures of questionable efficacy even comparable to life-saving medicines for impoverished children?

My impression is that this may be the work the Foundation undertakes for show, in the kind of public-relations move you suggest in your post. An exclusive focus on global health would seem vaguely wonkish and elitist to the average American -- so to secure the reputations of Microsoft and the Foundation, Gates made the awkward bipartite arrangement we see today.

Ironically, an ideal tax policy for the Gates Foundation would be opposite Posner's suggestion: the public health work seems unambiguously worthy of tax breaks, but the education component is PR-related and a reasonable inclusion in the tax base.

The hard question, however, is how we could possibly quantify all these impressions and come up with an effective tax policy for nonprofits. I'm afraid that it probably can't be done; we either have to tax everything or tax nothing.

In The Netherlands, where much research is funded directly by the government, a relatively small fraction of research money is disbursed by way of competitive grants. A lot of it is given to a very limited number of full professors at (de jure or de facto) state-run universities, who then pass it on to their inferiors of many and varied academic ranks entirely unheard of in the US. The system is fuzzy and it is not entirely clear to me how it is run, but it seems to depend on seniority more than anything else. There has been a shift toward American-style funding based on grants awarded on the basis of specific proposals, but university hierarchs have been loathe to give up control over funding (competitive grants would somehow endanger their "independence"), and they actually have a fairly good lobby.

Anyhow, I think the Dutch system, and other yet more stodgy ones like the French and German systems, has been able to get stuck in a mode where funding is disbursed on the basis of seniority rather than merit largely because so much of the funding comes from the government.

I agree with your comment about Microsoft. In particular, education programs that involve providing schools with "free" Microsoft software obviously are good for Microsoft, whereas it is not entirely clear that they are good for the schools or for the future of education in general, and it seems almost obvious that they are a waste of money compared to similar programs based on free and open source software such as the One Laptop Per Child initiative.

I also recall, although I do not know if this was in connection with the Microsoft Corporation or the Gates Foundation, that tax deductions for in kind gifts of software were based on "market" value of the software in question, which is patently ridiculous, given that most commercial software these days is not a transferable commodity but a licensed service that is sold for vastly different prices to different groups of consumers. I do not understand the social benefit of subsidizing price discrimination, which is effectively what happens in such cases.

This post is directed mostly toward a previous comment, rather than Judge Posner's article.

The whole point of freedom, be it individual freedom or freedom of association, if one is to believe Mill or Hayek or Popper at least, is that by allowing each agent (citizen, foundation, ...) to pursue their own idea of what's a Good Thing to do you work around the limited understanding and foresight of even the most benevolent central planner. Any government policy based on the idea that charitable giving is to be encouraged if and only if it goes toward a number of hand-picked policy areas defeats the purpose of having private initiative to begin with, which is that by allowing a diversity of perspectives and objectives, you much increase the chance that somebody will hit upon a great idea that the priority-picking bureaucrat could not have thought of. In particular, the most effective charitable projects are often distinguished not by the immense amount of money they spend but by innovative ideas for how to spend it. The best way to get a lot of such innovative charitable projects is not to restrict a priori the range of activities considered charitable, or at least not too much.

To give an example, somebody recently started a foundation to provide loans to struggling independent media organizations in countries with oppressive regimes. They resell these loans in the form of bonds with anything between a normal interest rate and no payback at all, which are bought off them by investors/benefactors with various preference profiles for investment and charity. This foundation seems to have hit upon a model that allows them to do a rather surprising amount of good in the world with relatively little up-front capital. In fact, they have managed to convince government aid agencies to be among their benefactors. And yet it is easy to imagine a regulatory regime for charity in which this would not have been possible.
Some charities may even have goals directly opposed to government policy. Take for instance MAPS, a charity that funds research aiming to develop currently illegal psychedelic drugs for medical purposes. If their expectations turn out to be right, their research could be an enormous advance in the treatment of otherwise notoriously hard to treat psychiatric conditions such as obsessive-compulsive disorder and post-traumatic stress disorder. In fact, given the relatively modest resources required for their research, I think it would make complete sense for, say, the NIH to be funding it even if it had only a small chance of succeeding. Yet by the kind of reasoning the previous commenter applies, where the government allows itself to favor certain charities based upon its own ideas of which types of goals are likely to be useful, would it not be likely that they would find a way to bend the rules against MAPS? After all, very few things make better electoral politics than a juicy drug scare.

tax deductions for in kind gifts of software were based on "market" value of the software in question,

I think this is incorrect, and that in kind gifts by businesses are deductible only to the extent of their cost. I was unable to confirm this on the IRS web site, but it makes sense, since otherwise a firm could effectively eliminate any tax liability by donating enough of is products and taking a deduction for FMV defined as retail price.

The issue here is the way the "cost" of software is determined. If I donate 10 barrels of crude oil to a school, you need only look in the day's paper to obtain the current price, which should be a decent estimate of the marginal cost of producing oil. Software licenses, on the other hand, have near-zero marginal cost, but they can be sold above marginal cost because of the (limited) monopoly enforced by copyright law.

It is very discouraging that Posner almost totally fails to appreciate the ethical imperitive that confronts Western affleunt peoples when faced with the truly awful plight of poverty and diesease in other nations. Peter Singer's recent New York Times article about charitable philanthropy focused on this issue almost entirely. Singer's advocacy for personal charity as a matter of moral duty is a convincing argument. By side stepping this issue Posner fails to address the heart of the matter. His suggesstion that Gates' charity is a mere PR move is extremely distasteful. Judging by his post, one might assume that Posner views Gates' foundation as, at best, a fools errand and at worst, a destructive folly which undermines US foreign policy. Even if Posner doubts whether charitable moral duties exist (especially for the very weathly), he should at least have explicated his justification for such a view. As it stands, Posner's disregard for those less fortunate is a cold oversight from such a rigourous thinker.

C'mon Matt...nice try on the spin but that just doesn't cut it. That wasn't Posner's subject or intent.. but who the hell are you to tell any of us what our moral duty is anyhow? You wanna feed the world as your moral duty...go for it. But don't tell me it is my moral duty to subsidize your passion with MY tax dollars. I think I have the MORAL right to have my elected representatives decide how those dollars are spent OR they should leave them in my pocket so I can subsidize my own causes.

Interesting topic. I began considering the "foreign aid" which led to the tax deductibility question of large foundations trying to help the least well off in the world, or perhaps even spending their money on something directly in opposition to current foreign policy, such as a "Peace" movement, expansion of the powers of the UN, or an effort to ban all nuclear weapons and their means of delivery.

But, I was soon balled up in considering inheritance tax policy itself and perhaps its effects on creating foundations in the future. I'm not a tax guy but I think these are the general rules (pre "death tax" exemption)

For those passing on a million or two it is truly an untaxed event as the farm or stock is passed at market value on the day of transfer and the capital gains liability of the parent is no longer an issue for the heirs.

Above the exemption limit it is the same case of inheriting a new basis but the overage is taxed at 40% or so.

I'm less sure what the "no death tax" policy does but if it's what the Walmart heirs and other strong lobbying efforts favor, it is to allow passing the whole fortune forward under the same exemptive terms once meant to help poor farm families keep their farms. But I'm not sure that's how it is, or would be written and it may contain a nasty little hooker for the family farmer, if it's written such that the heirs adopt the same position as the parents, ie, a free transfer but with the owner's original tax basis with a capital gains tax due upon the sale of the assets. For the top group it's still quite a deal as the 40% estate tax would be swapped for 15% cap gains tax while those below the exemption would wake up to find a new 15% tax on the far more numerous estates of a million or so.

If we're really considering "no death tax" at all I suppose there will be far fewer charitable foundations as fortunes could pass to the heirs to do as they please which I suspect will continue to create a wealth based plutocracy that would have our founders spinning in their graves.

It's interesting to consider the Gates and Buffet fortunes as they are similar in having an extremely low basis of original shares of MSFT and Berkshire that have never been taxed so a gain is due on essentially the whole fortune. Under the "old" rules the 40% estate tax is but 25% for having rid the heirs of the capital gains tax obligations; still a "hit" but not much more than the average guy pays in income taxes.

So where do we end up? It strikes me that the owner of the fortune has chosen not to "keep" his fortune by passing it on to family and funding government priorities with 40% of it, but to pay a higher price by giving it away to a trust he may like but ultimately will have no control over its decisions. I end up thinking the funds in the foundation owe no more loyalty to US priorities than would a spare $100 of my own money that I might send to Africa or donate to a Ban The Bomb effort or other project inconsistent with current US policy.

As borders are becoming less relevant in terms of commercial activity it makes sense that a foundation might take a borderless view in prioritizing there good works, and not the least in the case of AIDS as its not an "African problem" but a problem endangering every tribe anywhere in the world.

Matt, it's interesting to consider the "ultimate good works" but you'd surely go crazy trying. While you may favor hands on compassionate medical care, another doctor my leave that post and do research on a cure, using seed money from a financier and so on.

Then the areas of most dire need for charitable works are mostly where the worst failures of public policy have taken place.

One could argue that a well managed capitalist economy combined with a functioning democracy that most people would be doing their best works just by going to work every day in what may seem their own self interest. The combination should bring the highest and best use of a nation's resources and distribute them such that few are in need of charity and that there is a surplus to help those who do fall through the cracks.

To that end, even the smallest incremental improvements in education at all levels will pay rich dividends.

It is funny that Posner suddenly becomes a skeptic of the free market, because he does not completely agree with the funding strategy of the Gates foundation. Like many other conservatives, Posner seems amazed that the wealthy (whom conservative intellectuals revere as god-like figures) sometimes want to spend their money on good works instead of conspicuous consumption. What a strange conundrum for a conservative when the free market yields "liberal" results.. :-)

I wonder if Posner would turn his skeptical eye on, say, the Olin Foundation. Or perhaps on many other sorts of tax breaks for billionaires that do no public good and cost the treasury billions. It seems a little petty to pick on charities just because they fund things that George W. Bush wouldn't.

This comment is full of errors, sweeping generalizations, and unsupported prejudices:

Posner says:
1. "it is subject to no political controls" -- Foundations like other charities are subject to supervision by local Attorneys General. This is often cursory, but sometimes quite strong. Other public and quasi public institutions may also step into the same role. Consider the actions taken with regard to the Bishop Estate,in Hawaii.

2. "this limits the ability of staff to appropriate the foundation's income for its personal benefit." A corrupt staff wouldn't be limited to use of "income." But the Private Foundation Rules in the Internal Revenue Code (Sec. 4940 - 4948) were intended to control such abuses, and succeed to some extent.

3."foundation staff work is attractive to liberals" -- who works at the Heritage Foundation, who worked at the Olin? are there statistics to support this statement? or is it simply a tautology and such work is attractive to all people (both liberals and conservatives) who are interested in a good job, with possible public impact.

4. "business values are conservative" -- isn't this also a tautology? Is "conservative" here a synonym for "non-altruistic?"

5. "If rich people want to squander their money on feckless foundations," -- Carnegie, Rockefeller, Ford -- did they "squander" their money? Did Carnegie "squander" his money on public libraries? Are their foundations "feckless?"

6. "I have trouble understanding why American taxpayers should (via the tax breaks for charitable giving) help finance foundations' contributions to foreign countries." -- Individuals account for most of that giving. Of the total $260 billion in charitable giving in 2005, 76.5% was from individuals. And so far as I know, what part of this giving goes abroad is not "to foreign countries," but to programs in foreign countries.

Posner's crabbed and narrow view of human motives and behavior may explain why he cannot comprehend charitable actions, but that simply exposes the limitations of his world view. Foundations represent attempts by individuals to perpetuate their values -- their values at the time they create or provide for the creation of the Foundations. They are often created at the end of a life of acquisition. It should not surprise us if, at the end of such a life, perhaps informed as Posner supposes by "conservative values," some individuals espouse other values. There are many examples, Scrooge first among them.

The Gates Foundation helps to polish Microsoft's image. There is nothing wrong with corporate image building, but there is no reason to favor it with tax breaks. Bill's charitable deductions may be limited by the "percentage limitation" (i.e., he can only deduct 20-50% of his adjusted gross income), but if instead he contributed the money to Microsoft, which would deduct 100% of every dollar spent on "polishing" its image. So this is a false dilemma. I also question the appropriateness of American foundations' spending money abroad. A foreign aid program is an instrument of U.S. foreign policy that can be undermined by private expenditures in the amount now being spent abroad by the Gates Foundation. this is very interesting dilemma. To begin with, tax deductions for foreign giving are difficult to substantiate, and the foreign recipients must be similar to U.S. charities (i.e., exclusively devoted to generally recognized charitable & educational purposes and keep adequate records of their expenditures) That restriction ought to limit outright cross purposes between individuals and the U.S. Federal government. More to the point, if decentralization is good for domestic charitable expenditures, is it so much worse for international affairs? Personally, I like the idea of many Americans out there burnishing the image of the US as helpful and giving, as supporting liberty, education, health and charity.

I think it is rather courageous, and I don't even have a case in his court, that Judge Posner asks the question about tax exemption for foreign projects. Once you have been in business just a little while, you realze that a significant protion of the money you are making is not yours; you are merely a trustee for the government. So this is short circuited, so to speak, by any charitable giving. I am reminded of an article in UT Southwetern (Dallas, TX) Medical School's newsletter. A wealthy couple was being lauded for contributing to a Psychiatry Professorship. In their remarks, one of them noted that they had a schizophrenic son and that he couldn't get SSI in Dallas; he had to get it through a New Hampshire Social Security office. The poor fellow of Mexican descent (even parents citizens, please) may not have that option here. Anyway it's in one door and out the other to some extent with the medical school charity giving in this case. I feel better about Gates than I do Bono, a Messiah of government charity, who recently changed his residency status to escape the Irish tax bill. Nevertheless, Judge Posner brings up an interesting persective.

As for the Gates and Buffet and the others who have set up chatitable foundations in the past, they seem to have found out that they are "damned if they do and damned if they don't". What a tough situation. ;) I've always believed that charity ought to start in your own backyard.

As for the problem of counteracting Foreign policy, that's really nothing to be concerned about. If it gets bad enough or compromises U.S. policy anywhere or at any time: the Congress, President and Courts have the power to deal with it in no uncertain terms. Perhaps, even classifying it as a form of treason. This country hasn't had a good treason trial since the likes of "U.S. vs. Burr". It's very easy to become "A Man Without a Country".

Our government (and every government) is more than capable of counteracting its own foreign policy. The actions of private charities matter no more or less to that than the actions of private businesses.

If a "conservative" philosophy demands that everyone compete equally in various markets, why should the law protect the right of wealthy people to perpetuate their wealth for the benefit of their family members in the form of foundations which receive special tax considerations from government?

Shouldn't the children of those who first accumulate great wealth (and it takes at least significant wealth to establish a serious foundation) be barred from government support in the next generations? Or is competition only necessary during the formative years of great wealth, the first generation -- and monopoly the norm for later generations? When we talk about charitable foundations in the USA, we are talking about a direct government protection for a certain type of activity and for those employed and engaged in that activity. Isn't it true that most of the boards of major foundations consist of the families of those who established the foundations, even into several generations removed from the founders?

How are the children of the wealthy in future generations competing anywhere, if, among other things, their main work is on the boards and staffs of the foundations their families established, years or generations before them?

In cases where the foundation's wealth is in stock in the family business (say, Ford, or HP) isn't this simply a way of monopolizing into future generations the wealth produced in an earlier generation? An additional question would be how those stock holdings relate to the governance of the corporation itself.

Finally (for this night early in the new year), there is the question about the factual basis for the assumption that foundations over the generations move towards "liberal" giving programs. Although this has been assumed since Simon recommended that conservatives target charity, was it ever examined? Although some dramatic examples may exist of those tendencies, has anyone actually itemized all of the kinds of giving from all of the major foundations, based also on some taxonomy that allows an identification of "liberal" versus "conservative" recipients? Or is this something that is, like the founding Truths of the USA, self-evident?

To raise one last question for this context: Are the Gates dollars going to AIDS work a "liberal" or "conservative" giving?

I have trouble understanding why American taxpayers should (via the tax breaks for charitable giving) help finance foundations' contributions to foreign countries.

Posner's objection is poorly considered. We might as well ask why taxpayers should help finance foundations' contributions, or individual contributions for that matter, to private universities, or religious organizations, or...

And if he does want to argue that only money spent in the US should be deductible, what of organizations like CARE or the Red Cross? These groups spend a lot of money in foreign countries. Shall we cut them off as well?